SFHA Scheme – will it be alright on the night?

I remember with some fondness Denis Norden and his clipboard each Christmas taking us through another collection of bloopers and mishaps. The strange thing was that the title was a bit misleading as it quite clearly never was alright on the night.

Participants in the scheme now have some difficult decisions to take by the end of February about the basis on which they will accrue future benefits within the scheme from April onwards. Before taking that decision associations really need to look closely and completely dispassionately about the potential implications of their actions, as this decision is highly significant for the future of many organisations and the service level they offer.

The table below shows the growth in scheme assets and liabilities between 2003 and 2009 with a very broad brush estimate of the possible picture in 2012 shown for illustrative purposes. The 2009 cessation liability is also an estimate as at the time of writing this it has not been published by the Pensions Trust.

The key points to note are:-

Liabilities grew by over 40% on an on-going basis from 2006 to 2009.

Asset values only grew by around 10% over the same period (which is a pretty disappointing result relative to the growth in the liabilities and not something which can be wholly laid at the door of market conditions).

This meant that the deficit increased from £53.5m to £160.1m equating to a funding reduction from 83.4% to 64.8%.

The funding basis used is very aggressive. For example, the pre-retirement interest rate is set at around 3.5% per annum in excess of government bond rates (compared with 1.6% per annum in the 2008 valuation of the Strathclyde Pension Fund). If a more prudent basis was used the liabilities and therefore deficit would increase further.

The cessation deficit was £339m in 2006. I have not seen an updated cessation figure for 2009 but if we allow for expected growth in cessation liabilities, the cessation deficit is likely to have risen to somewhere in the order of £500m.

It is important to note that even if the scheme had been 100% funded on an on-going basis the cessation deficit would still be of the order of £350m and a funding position of only 56%. Clearly however it is not!!

This is a relatively immature scheme so liabilities will continue to rise rapidly and the cessation gap is likely to widen, although it will be slowed to some degree if participants chose lower future accrual rates. The cessation deficit is important as although it would only be payable if someone exited, which is likely to be unaffordable for most, it represents the amount which would be due in the event of an organisation ceasing to trade or becoming insolvent or where a cessation event was triggered inadvertently. Whilst the sector is strong insolvencies could not be ruled out and unlike historically, another organisation is unlikely to assume responsibility for prior pension liabilities thereby increasing the level of orphan debt distributable amongst the remaining participants. Smaller organisations may struggle to keep participants within the scheme given rising member contributions, and if no active members participate this could trigger a debt which is unaffordable for the organisation. Organisations will either need to come up with convoluted structures just to avoid this happening or face insolvency.

The aggressive nature of the funding basis means that there is no guarantee that the basis would be accepted by the Pensions Regulator. I’m sure a number of other sponsoring employers wait with interest to see if such a basis is accepted!! If it is not there will be additional complexity and an inevitable further increase in contributions.

So what might happen in the future? If the funding basis is accepted then there is a very high probability of further contribution increases in 2013 following the 2012 review, with deficit contributions fully picked up by the employer given the proposed change to the contribution basis. If it’s not accepted then the higher contributions will come much sooner.

If we make an assumption that assets and liabilities both increase at the same rate over the next 3 years (I’ve assumed 40%) whilst the funding percentage would remain the same, the level of the monetary on-going deficit would increase to over £200m. Total cessation liabilities are likely to top £1.0Bn with a deficit increase to in excess of over £600m. Clearly, if liabilities continue to outstrip assets then the position will worsen further.

So before you take a decision to stick with the status quo, make sure you understand the implications for your organisation and staff as if it’s not alright now you’ve really got to ask yourself, is it likely to be any more alright in the future?